Box? What Box?

On Benefits & Losses from International Trade

Posted in Uncategorized by uhniche on November 14, 2009

International trade exists on the premise that every country cannot produce all that they require using their resources within a given cost bracket and/or quality requirements. International Trade is the exchange of goods and/or services between entities from two or more different countries. In economics, we attribute International Trade to Comparative advantage. Mankiw states ‘all countries can benefit from trading one another because trade allows each country to specialize in doing what it does best.’ This simply means that countries have an advantage over the others in producing a particular good or service which the others may not be able to produce at a given price point or quality requirements. This puts the competitive advantage in the hands of the former and allows the latter to procure goods and services from the countries which are more competent in producing that good or service, and allow for the buying country to employ its resources in production of other goods and services. International trade also includes transfer of resources of production, particularly capital, from one country to another. This, however, does not go to say that countries that do not trade internationally don’t produce all of the goods and services required by them.

Benefits of International Trade

International trade, at face value, has one basic benefit – allowing for purchase of goods and services at low prices. This puts more income in the hands of households as they can use their disposable incomes in purchasing cheaper goods and services. The country as a whole benefits as well as its resources can be applied in producing goods and services which it has a comparative advantage in producing and add a larger contribution to its GDP. The sellers of an exporting country get the advantage of increasing their prices in-line with the world prices, which would ideally be higher than the domestic prices if the exporting country has a competitive advantage in producing the commodity to be exported. This puts in more money into their pockets, hence increasing their profitability and their contribution to the GDP and tax revenues. Trade can also force prices to fall. If the domestic producers face competition from foreign countries which offer similar commodities at lower prices, they have to, normally, lower their prices in order to maintain competitiveness. This allows for households to purchase goods and services at lower prices, hence increasing their individual purchasing powers. This, however, only stands true if the commodities in concern are close substitutes or are almost identical. In cases where commodities being imported are of inferior quality, then they act like inferior goods and their sales increase once incomes fall. Exports also allows for countries to earn Foreign Exchange which not only helps them meet their international debt obligations, but also allows for an appreciation of their currency. Exports also allow for domestic producers to achieve higher economies of scale as they have the opportunity of producing more of a commodity, hence absorbing a larger amount of fixed cost at any given time while reducing their prices as lesser fixed costs are charged per unit. International trade also provides consumers with a wider variety of options to choose from for the same or similar product types as imports from other countries may be distinctly different in functionality and aesthetics from the domestic produce.

Losses from International Trade

International trade increases dependency of countries on other countries. Countries that import essential commodities from other nations become dependent on the exporting nations for the fulfilment of the need of their people of that commodity. This happens because the domestic producers are often de-motivated from producing imported commodities of identical attributes that are available at lower prices in the market. These producers move on to production of other commodities and reduce the domestic supply of these commodities. This also limits growth of industries in the importing country as incentives that a producer derives from operating in a particular industry may be minimized with the introduction of import substitutes, which may be of superior quality and utility. Often, countries import essential commodities that cannot be produced domestically or can only be produced in small quantities which do not meet the demand for them. For example, most countries around the world import oil from OPEC, Venezuela etc. as their domestic supplies don’t match up to their domestic produce. This makes them dependent on these oil exporting countries for a commodity as basic as oil. If these countries stop exporting oil, most of the world would come to a standstill in a matter of weeks as the worldwide demand can only be met by their supply. On the flip side, if producers of a country find comparative advantage in international trade of a particular commodity, they start focussing on exports of that particular commodity and can sometimes manage to have an upper hand over some country, which they may use to their benefit. Another aspect of this is that producers, who focus on exports, increase the domestic prices in line with the world prices, which essentially reduces the purchasing power of consumers as they have to shell out more cash for the purchase of the commodity in concern. The fact is that very high dependence on foreign imports can often lead the trading countries to become susceptible to the economic, social and political environmental variables of their counterparts.

India’s Case

Pre-liberalized India (Independence to 1991) had a whole lot of trade barriers, particularly pertaining to imports. The government followed an import substitution policy in order to help develop local industries, most of which remained stuck in their infant stage for a large part of this period. During this period, India only managed to attain a, what was then known as, the “Hindu Growth Rate”, i.e. 2-3% growth in GDP every year. The problem here was that the country was still developing and such a growth rate was unacceptable, given the resources the country had. And with the growing population of the country, serious action was required to ensure survival. The tipping point, perhaps, was a point in time during the early 1990’s when the country only had enough foreign exchange to purchase a few more days of oil – an essential commodity for survival. When India turned to international lending institutions, they were clear on their approach – open up your borders for trade and investments. This led the country toward liberalizing its trade policies. Cut to about 17 years later, the country is growing at about 8.7% per year with adequate foreign exchange reserves. All this can be attributed to international trade. For example, India has a competitive edge in IT services – specifically software’s and business process outsourcing. This industry is primarily dependent on providing services to US based organisations which hire India’s resources as the labor required for these services is significantly cheaper in India than the US. This motivates US based companies to employ Indians in India and Indian companies for obvious reasons. The government gains as foreign exchange keeps pouring in and unemployment is cut marginally. The employees get jobs that pay a decent sum of money for their services. Everything, however, isn’t all hunky-dory. India’s dependence on the US has increased significantly as India’s growth has been also because of foreign investments pouring in from various countries which means that if the American economy faces a recession, the Indian economy suffers as well – which is exactly what’s happening right now. The overall growth rate of the country is affected and expected to fall down to a 7% mark as opposed to the projected 9+% mark. The people employed in these organisations suffer as their career growth takes a beating, banks and financial institutions also face the crunch. India’s trade dependence with the rest of the world then makes it more vulnerable to their actions than it would have been had it not liberalized. It is then a matter of choice – slow growth vs. Vulnerability to the world’s economies.

Reference: Mankiw, Economics

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